Israel was defiant on Monday in the face of a serious diplomatic rift with five European countries over its plans to expand illegal settlements in the West Bank, warning that it may take "additional steps" despite mounting international alarm that it was killing off any prospect of a future peace agreement with the Palestinians.

Israeli ambassadors to the UK, France, Sweden, Spain and Denmark were summoned to hear condemnation of plans to develop a highly sensitive expanse of land east of Jerusalem. The move signalled a widening gulf not just between Israel and Europe but also between Europe and the United States.

Despite growing international isolation, a source in the Israeli prime minister's office said: "We will continue to stand by our vital national interests against international pressure and there will be no change in the decision that was made."

The source added: "There should be no surprise that Israel will not stand idly by in the face of unilateral Palestinian steps. If they continue taking unilateral steps, Israel will act accordingly."

The sharp rebuke issued by the five nations followed an announcement last Friday that Israel would press ahead with plans to build settler homes that will close off East Jerusalem from the rest of the West Bank. The move came hours after the Palestinians won recognition of their state at the United Nations general assembly.

Only eight countries out of 193 voted with Israel against Palestinian statehood. Despite vigorous efforts to win over European countries, only one – the Czech Republic – rallied to Israel's side.

The British minister for the Middle East, Alistair Burt, formally summoned the Israeli ambassador to London, Daniel Taub, to the Foreign Office to convey "the depth of the UK's concern" about the decision and to demand its reversal.

In a statement, Burt said: "The settlements plan … has the potential to alter the situation on the ground on a scale that threatens the viability of a two-state solution."

The Israeli ambassador to Paris was formally told of France's "serious concerns" and reminded that "settlements are illegal under international law, destroy confidence in reviving dialogue and constitute an obstacle to a fair peace based on a two-state solution", according to a statement.

European countries were furious at Israel taking punitive measures in response to the UN vote, with one diplomat describing the steps as "cynical", "self-destructive" and "outrageous". Israel announced 3,000 new settler homes, the preliminary stages of the E1 development plan and the withholding of more than $100m (£62m) in tax revenues it collects on behalf of the Palestinian Authority.

A Palestinian official, Nabil Shaath, welcomed the European diplomatic response. "For this to come from France and England is very beneficial to us. We highly appreciate it and we are hoping the US will follow their lead," he said.

However, there was no parallel move from Washington. The last year has seen a growing divergence between Europe and the US, with many EU countries taking a more robust approach to Israel's continued settlement expansion. Some European diplomats believe that the EU must exert pressure on Washington to force the two sides to return to negotiations.

The Israeli prime minister, Binyamin Netanyahu, has repeatedly said he is willing to resume talks with the Palestinians, though many diplomats are deeply sceptical about the value of such statements when Israel continues to expand its settlements across the pre-1967 line. The Palestinians say settlement construction must cease before talks can begin following more than two years of stalemate.

Earlier on Monday there were suggestions Britain and France were considering recalling their ambassadors to Israel. However, a Downing Street spokesman said: "We are not proposing to do that. We are not proposing to do anything further at this stage … Clearly, we are concerned about the situation … but we are not setting out any further action at this stage."

There was no reciprocal move by the US, but a state department spokesman, Mark Toner, said any building in the E1 area was contrary to US policy. "The United States opposes all unilateral actions, including West Bank settlement activity and housing construction in East Jerusalem, as they complicate efforts to resume direct, bilateral negotiations, and risk prejudging the outcome of those negotiations," Toner said. "This includes building in the E1 area as this area is particularly sensitive and construction there would be especially damaging to efforts to achieve a two-state solution.

"We have made clear to the Israeli government that such action is contrary to US policy. The United States and the international community expect all parties to play a constructive role in efforts to achieve peace. We urge the parties to cease unilateral actions and take concrete steps to return to direct negotiations so all the issues can be discussed and the goal of two states living side by side in peace and security can be realised."

Israeli plans to develop E1 have been on hold for more than a decade, largely due to US pressure. Construction of Israeli homes, hotels and businesses in the area would make it almost impossible for East Jerusalem to become the capital of Palestine under a future agreement, and would almost bisect the West Bank. Western diplomats regard the development of E1 as a game-changer with regard to a two-state solution to the decades-old conflict.

At a cabinet meeting on Sunday, Netanyahu rejected criticism of the decision to activate the plan. "We will carry on building in Jerusalem and in all the places that are on the map of Israel's strategic interests," he said.

Netanyahu's stance is expected to find wide support among the Israeli public, who will go to the polls in a general election next month. Netanyahu's rightwing coalition is on course to emerge from the election with the largest number of seats in the Israeli parliament.